Why Would Someone Create a Trust?
When people hear the word “trust,” they often associate it with wealthy families, complicated estate plans, or generations of family wealth. While trusts can play an important role in sophisticated estate and tax planning, they are not limited to the ultra-wealthy. A trust is a tool for individuals and families who want greater control over how their assets are managed, protected, and distributed.
A trust is a legal arrangement in which one person or entity (the trustee) holds and manages assets for the benefit of another person or group of people (the beneficiaries). The person who creates the trust is called the grantor or settlor.
There are many different types of trusts, and the appropriate type for you depends on your goals, family circumstances, assets, and estate plan. Everyone does not need a trust, but it can provide benefits that a will alone may not accomplish.
So, why would someone create a trust?
1. Estate Planning
One of the most common reasons people establish a trust is to help accomplish their estate planning goals.
Part of estate planning is deciding who receives your assets after you die, but it also involves determining how, when, and under what circumstances those assets will be distributed.
For example, suppose a parent wants to leave $1M to a child. A simple estate plan might say that the child will receive the entire amount upon the parent's death. However, the parent may have concerns about whether the child is prepared to manage a significant amount of money at once.
A trust can provide more flexibility. Instead of distributing the entire inheritance immediately, the trust could establish more specific rules like distributions that only occur at certain ages, upon reaching specific milestones, or based on particular needs.
This can allow parents and other individuals to incorporate their wishes and priorities into their estate plan while still providing financial support to their beneficiaries.
A trust can also be part of a broader estate plan that includes a will, beneficiary designations, powers of attorney, and other legal documents, all which work together.
2. Avoiding or Simplifying Probate
Another common reason for establishing certain types of trusts is to avoid or simplify the probate process.
Probate is the legal process through which a deceased person's estate may be administered. It can involve validating a will, identifying and valuing assets, paying debts and taxes, and distributing property to beneficiaries.
Probate requirements vary by state, and not every asset goes through it. Assets that are properly titled in a trust, for example, may instead be administered by the trustee according to the trust document. This can streamline the administration of an estate for the surviving family members.
However, creating a trust does not automatically accomplish this goal. The trust must be properly funded, with assets appropriately transferred or titled. Proper implementation and ongoing maintenance are important parts of the process.
3. Providing for Children or Other Beneficiaries
Trusts can also be useful when someone wants to provide financially for children, grandchildren, charitable organizations, or other beneficiaries.
This is especially true when beneficiaries are minors, since they generally cannot manage a significant inheritance independently. So, assets may need to be managed by a parent, guardian, custodian, or another individual until the beneficiary reaches the applicable age.
A trust can establish a framework for managing those assets.
For example, parents may create a trust for their children that allows the trustee to use trust assets for education, healthcare, housing, or other needs. The trust can then provide additional distributions when the children reach certain ages.
The exact provisions will depend on the family's goals, but the idea is that the person creating the trust provides financial resources without giving the beneficiary immediate and unrestricted control over them.
4. Managing Assets for Beneficiaries Who May Not Be Ready to Manage Them
An inheritance can be life changing. But receiving a large amount of money does not mean someone is prepared to manage it.
Parents may have concerns about a beneficiary's age, financial experience, spending habits, or ability to make long-term financial decisions. A trust can address these concerns.
For example, a parent may want a child to have access to money for college, a first home, or other significant expenses but may not want the child to receive a large lump sum at age 18 or 21.
Instead of giving that child complete control over an inheritance immediately, the trust can appoint a trustee to manage the assets according to the trust's instructions. The trustee may have authority to make distributions for the beneficiary's needs while preserving some of the assets for the future.
This can also be useful when a beneficiary has special needs or other circumstances that require additional planning. In those situations, specialized trust structures may be appropriate, and legal advice is especially important.
5. Privacy
Privacy is another consideration when evaluating whether a trust makes sense.
Probate can involve court filings and potentially public records. On the other hand, a trust can allow assets to be administered privately.
Privacy can be meaningful for families with substantial assets, business interests, or complex family situations. Keeping the details of an estate out of a public probate proceeding may reduce the amount of information available to people outside the family.
It is important to understand, however, that a trust does not make every aspect of someone's finances automatically private. Different types of trusts have different reporting and disclosure requirements, and tax returns and other legal or financial records may still be required.
The privacy benefits depend on the type of trust and how it is structured and administered.
6. Asset Management During Incapacity
Estate planning is not only about what happens after someone dies. It should account for what happens if someone becomes unable to manage their own affairs due to illness, injury, cognitive decline, or other circumstances.
A trust can provide a framework for managing assets if the person who created the trust becomes incapacitated.
For example, a revocable living trust may allow the grantor to manage the assets while they can. If the grantor later becomes incapacitated, a successor trustee may be able to step in and manage the trust assets according to the trust's terms. This can create continuity in asset management and reduce the need for court proceedings.
However, a trust is generally only one component of an incapacity plan. Powers of attorney and healthcare directives also play important roles.
The goal is to create a plan that addresses financial and personal decisions before a crisis occurs.
7. Certain Tax and Wealth-Transfer Planning Strategies
Trusts also play an important role in tax and wealth-transfer strategies. Certain structures may be used as part of planning related to subjects like estate taxes, gift taxes, generation-skipping transfers, charitable giving, and business interests.
For example, high net worth families may want to take advantage of strategies to transfer assets to future generations while managing estate and gift tax consequences. Certain irrevocable trusts can be structured so that assets are treated differently for estate tax purposes than they would be if they remained in an individual's estate.
Trusts can also be incorporated into charitable planning. A person may want to provide for family members and support charitable organizations, and certain charitable trust structures can do both while also providing tax benefits.
However, tax planning with trusts can become highly technical. The tax treatment depends on the specific type of trust and how it is drafted, funded, and how transactions are structured.
This is why trust planning should involve coordination between the appropriate professionals, including an estate planning attorney, tax professional, and financial advisor.
Does Everyone Need a Trust?
No. A trust is not appropriate for everyone.
For some, a properly drafted will, beneficiary designations, powers of attorney, and other basic documents may accomplish their goals.
For others, a trust can provide additional control, flexibility, privacy, or continuity that may be difficult to achieve through a will alone.
If you want to know if you should establish a trust, ask yourself: “What am I trying to accomplish with my estate plan, and is a trust an appropriate tool to help me accomplish it?”
Family circumstances, asset levels, types of property, business ownership, beneficiary needs, state law, and tax considerations can all influence the answer.
This material is purely intended to be general and educational in nature, and should not be construed as specifically-tailored investment, financial planning, tax, legal, or other professional advice. Information and data contained herein is as-of the date of publication, and may be subject to change in the future without notice. Any investment performance referenced is purely past performance, which is no guarantee of any future performance. Nothing contained herein should be construed as an offer to sell, a solicitation of an offer to buy, or a recommendation of any security or other financial product or investment strategy. All investment, tax, and financial planning strategies involve risk that you should be prepared to bear. You are highly encouraged to consult with professionals of your choosing before taking any action based on this material.
